M&A Musical Chairs

Craft Business Daily:

M&A activity inside the industry has never been higher and it’s not subsiding anytime soon. First Beverage Group’s Townsend Ziebold told the audience at Brewbound’s Chicago Session that he believes there will be a little less than 25 craft transactions in the next 18 months.

You might be saying ‘that seems like an awful lot,’ but the firm predicts some serious headwinds over the next two years, and they feel it’s likely to precipitate a fair amount of craft brewers bowing out. As they put it, M&A the next two years is destined to be a game of “musical chairs.”

GATHERING HEADWINDS. Let’s start with distribution, which is “getting more expensive to gain and most importantly, getting very difficult to hold.” The demand for support from wholesalers is at an all-time high, according to Townsend.

“Now, if you’re nano and very local – it’s a little less relevant but if you’re in the top 10 to the top 150, wholesalers are demanding that you’re in their office with a real business plan and a real commitment and a real story behind your brands.” First Beverage believes this will necessitate increased investment over the next couple of years — “in reps … in marketing. They have to put more in administrative structure, more in systems,” he said.

Then there’s pricing. A-B’s buyout has given way to an environment of price increases for nearly a decade and provided “a nice umbrella effect to the beer industry as a whole,” Townsend said. But things could get hairy. The firm thinks the large domestic players aren’t going to compromise price integrity off-premise, but the on-premise is a different story. “Large domestics have a lot more flexibility on-premise and will become very predatory and very competitive,” he said.

To make matters worse, craft brewers can’t grow the same way they did back in the day, Townsend explained. If you’re looking to be a regional brand or hold a quasi-national craft strategy, Townsend foresees some tough times ahead of you. The top brands that have already “planted their flags” will be alright but if you’re looking to do that today – “it’s just a lot harder,” he said.

All this added up and “you’re ultimately going to get the margin erosion in the industry probably across the board.”

ENTER M&A. In turn, craft brewers are now thinking it may be time for them to get out before things take a turn down south. It’s no secret the craft business is getting harder and harder and CAPEX cycles are “getting larger and larger,” Townsend said. “When you go from 20,000 barrels to 40,000 barrels that’s expensive but it’s manageable. When you go from 200,000 barrels to 400,000 barrels, it really causes a lot of the founders that we work with to pause .” Townsend would say that the decision around CAPEX is one of the primary reasons they’re seeing some of their clients think about M&A decisions. Understandably, these are “$50, $80, $100 million decisions to build out your facilities,” he said. “So a lot of the founders are saying they’d like to take some chips off the table before I embark on a lot more leverage to expand,” he said.

A RECIPE FOR MULTIPLES. Not only that, but multiples are at all-time highs. Townsend said he fields the question, “What multiples should you put in my business?” all the time. The answer, he explained, “is the multiple is the result of the work that a PE or strategic buyer will do.” But multiples aren’t really on their mind. “They don’t say ‘oh your business is a 8X multiple and your business is a 15X multiple.'” What happens is: if you’re a PE investor, you’ll “run a returns model” and if you’re ABI/MillerCoors/strategic buyer – “you plug it into your old system and grow the brand on your own infrastructure.” You’re going to have synergies on production, sales, marketing, hops purchases, glass purchases, etc., he said. “But ultimately that all manifests itself in the returns multiples – the output of which is a multiple.” Townsend believes there will be a “race before the door closes on multiples.” He’s not sure when that will happen “but 5-10 years from now, they won’t be what they are today.”

Don’t get it twisted – it’s not apples to apples, he said. “If you have 150,000 barrels in one state like New Glarus and you have 150,000 barrels in 40 states like some of the San Diego guys, that has different ramifications on valuation. Another example is if you just finished a $50 million CAPEX spend, and if you don’t have to spend any significant CAPEX for the next five or six years.”

And of course, wholesaler alignment plays a pertinent role as well. “If you’re aligned with ABI or MC in the state of Texas, which has extremely rigid franchise laws, or if you’re in the state of California, where you can move for fair market value, or the state of New York, where you have carve outs – you could be worth 15X the EBITA to ABI in one state if you’re aligned with their wholesaler network and you could be worth $0 if you’re in another state and you have complete misalignment. “

So is the bubble bursting? Well no, but Townsend feels “we’re at the peak of the market.” He thinks “we’re at absolute peak in terms of operating performance for crafts,” as “EBITA margins are as high as they’re going to get” – they’re doomed to go down because they require investment in sales and marketing. On top of that, we’re at the peak period of “strategic need.”

SO WHAT ARE THE STRATEGIES? Here’s a rundown of available strategies: ESOP; minority sale and retain control; majority sale and retain control; multi stage deal with a strategic; outright sale to a PE or strategic; sell or merge with another craft brewer; roll-up to IPO. Then Townsend shared some of his apprehensions on these deals.

There’s an inclination to seek out strategic buyers because they can shell out the most money. Although, Townsend has found them to be the “most disciplined of buyers that they’ve dealt with.” He warned that “you’ll get the most out of a strategic, but don’t believe a strategic is going to get you rational on valuation.” Also, not everybody is going to get a “wonderful” deal like Founders (who took on Spain’s Mahou San Miguel as a minority partner) and Boulevard (who got bought by Belgium’s family-owned Duvel). “There isn’t a line of 15 other international strategics out the door,” and there’s a “risk of supply outpacing strategic buyer demand.”

ESOPs are something else to be careful about. “They’re complex, difficult to manage, hard to unwind. A lot of people like to do a 30% ESOP because of tax advantages but that comes with quite a lot of leverage. Excessive leverage in the context of a consumer business that’s capital intensive is a dangerous mix,” he said.

Another tricky strategy is rolling up to an IPO. They’re “really tempting but a real pain in the butt.” They require a lot of money and “only the very largest crafts should go public.”

2018 AND BEYOND. Despite the doom and gloom, First Beverage believes craft will eventually get to a 30-plus share. And don’t worry, the big guys aren’t going to gobble up 25 crafts — it’s more like four or seven, according to Townsend. We’ll have to kiss this period of low interest rates goodbye, making equipment more expensive. As always, expect more consolidation.